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Finance & Development
A quarterly magazine of the IMF
March 2007, Volume 44, Number 1

To the Editor

Deficits can harm growth

There is one important omission from the otherwise comprehensive article by Atish Ghosh and Uma Ramakrishnan, "Do Current Account Deficits Matter?" (December 2006): it does not address the long-run growth consequences of deficits. The orthodox view is that the balance of payments doesn't matter for long-run growth because growth is determined from the supply side by the exogenous growth of the labor force and technical progress and the balance of payments equilibrates without income adjustment. But there is now a substantial body of empirical evidence (see J. McCombie and A.P. Thirlwall, Economic Growth and the Balance of Payments Constraint, Macmillan, 1994; and Essays on Balance of Payments Constrained Growth, Routledge, 2003) that the balance between the growth of exports and the income elasticity of demand for imports does matter for long-run growth because real exchange rate changes are not an efficient balance of payments adjustment mechanism and it is income that contracts to correct deficits working through the dynamic Harrod foreign trade multiplier.

Thus, developing countries producing and exporting goods with a low income elasticity of demand and importing goods with a high income elasticity of demand are bound to run deficits if they attempt to grow as fast as other countries, but ultimately have to constrain growth because the deficits are unsustainable. This income adjustment mechanism is, of course, the basis of the famous center-periphery model of Raul Prebisch developed in the 1950s in the context of Latin America. But it applies equally today to many countries in Africa and elsewhere.

Tony Thirlwall
Professor of Applied Economics
Keynes College, University of Kent, U.K.

Trade deficits and lost keys

Thank you for "Do Current Account Deficits Matter?" It's amazing to me that the authors could explain something so complex in a short article so well. The article's conclusions seem to imply that the U.S. trade deficit is relatively benign. But I think the danger for the United States will occur when foreign investors become less willing to invest in that country, at which point interest rates will rise and slow the economy.

Separately, I enjoyed reading Lant Pritchett's "The Quest Continues" and his survey of development economics (March 2006). I think the research program he offers shows a lot of promise, too. Most of my work in economics has been in business, not academics, but Pritchett's descriptions of the faults of regression analysis are well known in business economics, especially in marketing. Standard procedure when using a regression in marketing is to cluster one's customers into fairly homogeneous groups first. Otherwise, a regression on all customers combined will produce an average customer that may not exist. A simple example often used is of a bank that has only very wealthy and very poor consumers. A single regression equation would satisfy the average customer, of which the bank has none. But clustering customers first and then creating regressions for each will allow the bank to satisfy both groups. What Pritchett proposes is similar to what marketing analysts do: cluster countries into relatively homogeneous groups. I think empirical works will have much more success following Pritchett's plan.

The next problem is specification. Researchers tend to suffer from the problem of the drunk who lost his keys and searched only around the lamppost because that's where the light is. If researchers continue to "round up the usual suspects" for their predictor variables, they won't make much progress. They need to look outside their comfort zone at the institutional research of Douglass North and others, as well as the cultural research of Lawrence E. Harrison and Samuel P. Huntington.

Roger D. McKinney
Broken Arrow, Oklahoma

Africa and bilateralism

With China's recent forays into Africa, the issue of bilateralism between Africa and the major world powers is very much in the news. The article by Abdoulaye Bio-Tchané and Benedicte Vibe Christensen in the December 2006 issue of F&D says African governments "need to be very cautious in assuming new nonconcessional loans so as to safeguard debt sustainability. They must also be mindful of the conditions for such lending—for example, ties to bilateral trade or the mortgaging of future exports for repayment."

The risk involved in China's economic overtures to African countries is that they will be swayed by immediate interests and risk jeopardizing their future. Cameroon's imports of Chinese goods have risen steadily since 2001, whereas its exports to China have stagnated. The trade balance between China and Cameroon has redounded to Cameroon's deficit and to China's benefit.

It is in this context that the reservations expressed by Bio-Tchané and Christensen should be understood. If African countries do not protect their interests in the partnership agreements, they might well be the losers.

I do not think Africa has much choice as to whether it should enter into partnerships with the major powers. But Africa, which is providing its markets, its land, its people, and its wealth, should not continue to behave like a beggar. It must demand its share of the dividends and ask that they be spelled out clearly in the agreements so that its people will benefit. The interests of a people and a whole continent are at stake in this era of globalization.

Israel Jacob Baruc Mekoul
World Bank intern, student in the Faculties of Law and Economic Sciences, Université Yaoundé 2, Cameroon